Category: Economics

Has the time for income-sharing arrived?

That is the topic of my new Bloomberg column, here is one excerpt:

To be sure, there are problems with the idea of equitizing human capital. For instance, what if less talented, less hard-working individuals turn out to be the most likely to sign away part of their future income? That creates a problem that economists call “adverse selection.” This is a real issue, but it hasn’t stopped companies from selling equity and startups from selling venture capital shares. As for the students, due diligence and talent measurement may suffice to identify enough good students with bright prospects.

There are also genuine questions about how far this model can be extended. The demand for labor is robust in information technology, but would a similar system work for philosophy professors or prospective musicians? In both cases incomes are undoubtedly lower, motivations non-pecuniary, and the chances for real success more remote. The company Pando Pooling, meanwhile, is trying equitization with minor league baseball players. The importance of raw baseball talent may be so paramount, however, that companies cannot much improve the labor market prospects of their clients.

Note also that we already equitize each other’s labor in many non-explicit, non-corporate ways. If two economists write a paper together, for example, each is tying his or her fate somewhat to the other. And if two people in business decide to share networks or trade favors, each has a stake in the success of the other.

The piece also consider Lambda School in San Francisco as an institution trying to operationalize this practice.

The friendship paradox and systematic biases in perceptions and social norms

Except I call it the Twitter paradox, and it is about how neurotics really get on each others’ nerves:

The “friendship paradox” (first noted by Feld in 1991) refers to the fact that, on average, people have strictly fewer friends than their friends have. I show that this oversampling of more popular people can lead people to perceive more engagement than exists in the overall population. This feeds back to amplify engagement in behaviors that involve complementarities. Also, people with the greatest proclivity for a behavior choose to interact the most, leading to further feedback and amplification. These results are consistent with studies finding overestimation of peer consumption of alcohol, cigarettes, and drugs and with resulting high levels of drug and alcohol consumption.

That is from Matthew O. Jackson in the new JPE.

Are top CEOs underpaid?

There is another lesson from the numbers: CEOs are paid less than the value they bring to their companies. More concretely, CEOs capture only about 68–73 percent of the value they bring to their firms. For purposes of comparison, one recent estimate suggests that workers in general are paid no more than 85 percent of their marginal product on average [Isen 2012]; that difference is attributed largely to costs of searching for workers and training them to become valuable contributors. In other words, workers actually seem to be underpaid by somewhat less than CEOs are, at least when both are judged in percentage terms. Both of those are inexact estimates, but in fact these results are what economic reasoning would lead us to expect. It may be easier to bargain the CEO down below his or her marginal product a bit more, given that the talents of the CEO would be worth much less in non-CEO endeavors.

I find the most convincing estimate of the gap between pay and marginal product to be that of Lucian A. Taylor, at the Wharton School of Business. He finds that a typical major CEO captures somewhere between 44 percent and 68 percent of the value he or she brings to the firm, with the additional qualification that the CEO’s contract offers some insurance value—that is, in bad times for the firm the pay of the CEO won’t be cut in proportion, but the CEO shares to a lesser degree on the upside. That 44–68 percent is therefore a better deal for the CEOs than it may appear at first glance. Still, you won’t find credible estimates suggesting that major CEOs, taken as a group, are capturing more than 100 percent of their value added. Here too, that is what you would expect from a competitive bidding process.

Part of the accompanying footnote: For the 68–73 percent estimate, see Nguyen and Nielsen 2014; for the 44–68 percent estimate, see Taylor 2013… It is a little-known fact that the current use of high-powered financial incentives for American CEOs still has not reattained the level it held in the pre–Second World War period.

That is an excerpt from my Big Business: A Love Letter to an American Anti-Hero, due out next week.

Loser companies

As economic profits grow larger, so do economic losses at the other end of the distribution. The bottom 10 percent of companies destroy as much value as the top 10 percent create, and today’s bottom-decile companies have 1.5 times more economic loss, on average, than their counterparts of 20 years ago (Exhibit 1). That means for every company that creates economic value, there is another company that destroys economic value. Yet these value-destroying companies continue to survive, holding on to their resources for increasingly longer durations and continuing to attract capital. A growing number are turning into “zombie” companies, unable to generate enough cash flow even to sustain interest payments on their debts. The impact of these economic losses goes beyond these companies’ investors, managers, and workers: it drives down the returns for healthy companies that compete for the same resources or profits.

That is from a new McKinsey study, via Marty Manley.

Preemptive Overfishing

The Endangered Species Act endangered some species and announcing that a fishing area will be protected in the future increases fishing now.

PNAS: Most large-scale conservation policies are anticipated or announced in advance. This risks the possibility of preemptive resource extraction before the conservation intervention goes into force. We use a high-resolution dataset of satellite-based fishing activity to show that anticipation of an impending no-take marine reserve undermines the policy by triggering an unintended race-to-fish. We study one of the world’s largest marine reserves, the Phoenix Islands Protected Area (PIPA), and find that fishers more than doubled their fishing effort once this area was earmarked for eventual protected status. The additional fishing effort resulted in an impoverished starting point for PIPA equivalent to 1.5 y of banned fishing. Extrapolating this behavior globally, we estimate that if other marine reserve announcements were to trigger similar preemptive fishing, this could temporarily increase the share of overextracted fisheries from 65% to 72%. Our findings have implications for general conservation efforts as well as the methods that scientists use to monitor and evaluate policy efficacy.

One puzzle is why there should be an increase in over-fishing? Shouldn’t a commons already be overfished to the point of zero return? One possibility is that previous steps to limit overfishing were working.

The possibility of preemptive overfishing suggests the utility of surprise protections, but that’s not always possible and the authors don’t suggest that preemptive overfishing makes protection unwise only that it has a short term cost.

Hat tip: Paul Kedrosky.

Is the corporation your friend?

The funny thing is, although it is wrong to think of corporations as people, it is probably also necessary for social cohesion. If the American people are going to support business in the court of public opinion, business must to some extent have a friendly face. Otherwise politics might treat business too harshly, ultimately leading to bad consequences for American private enterprise. Furthermore, consumer loyalty to corporations, even if irrational, is part of what induces better behavior from those corporations. Companies know that if they build up a good public image and stick around with a track record of reliable service, consumers will reward them with a kind of emotional loyalty. Overall, that creates a largely positive business incentive, one that would not be present if all consumers were more aware of the somewhat more cynical truth: that corporations should be judged not as friends but as abstract, shark-like legal entities devoted to commercial profit. The more that consumers see the relationship as possibly long-term, the more loyally profit-seeking corporations will end up behaving in a long-term and socially responsible manner. Societies need their illusions in this regard, and thus it can be dangerous to fully articulate and make publicly known the entire truth about business corporations and the fundamentally dubious nature of their loyalty.

So the trick is this: the public needs to some extent to believe in corporations as people, just to keep the system running. Workers need to hold similar feelings, to maintain workplace cohesion. Yet when it comes to politics and public policy, we need to distance ourselves from such emotional and anthropomorphized attitudes. We need to stop being loyal to corporations for the sake of loyalty and friendship, and we also need to stop being disappointed in corporations all the time, as if we should be judging them by the standards we apply to individual human beings and particularly our friends. Instead, we should view companies more dispassionately, as part of an abstract legal and economic order with certain virtues and also plenty of imperfections. Unfortunately, that is not about to happen anytime soon.

That is from the final chapter of my forthcoming book Big Business: A Love Letter to an American Anti-Hero.  Ah, and there is more:

One reason we like to think of corporations as our friends is that we can feel in greater control that way. I’ve already discussed just how much we rely on corporations—for our food, for our entertainment, for communicating with our friends and loved ones, and for getting around from one place to another. But for all the talk from economists about consumer sovereignty, it’s not clear how much people actually are in control at all. It’s true you can choose what to buy in the Giant, Safeway, or Whole Foods, but it’s hard to step outside the commercial network as a whole, and the nature of that network shapes so many of our choices and thus our lives.

Of course, it is impossible for customers to ponder these philosophical questions in their deepest and subtlest terms all day long, as that would consume way too much of people’s mental and emotional energies. So instead people translate their rather bizarre, non-hunter-gatherer modern commercial society into terms that their more primeval selves are familiar with. That is, people carry around a mental picture of being surrounded by people they can trust, if only salespeople, and of being in a familiar environment in which they are exercising their free will as consumers and also as workers. Given the need to get through each day, it is emotionally very hard for people to internalize emotionally the true and correct picture of those businesses as partaking in an impersonal order based on mostly selfish, profit-seeking behavior.

You can debate exactly how true or untrue our generally held picture of freedom in modern commercial society is, but I can’t help but feel that part of it is a lie. The system offers many formal properties of freedom, such as the immense choice of products and jobs, and the relative lack of imposed coercion on most of these decisions. Still, when you combine pressures for conformity, the scarcity of attention, the stresses of our personal lives, and the need for “ready quick” decision-making heuristics, it’s not exactly a life of true freedom we are living. It is (more or less) close to the freest life a society is capable of providing us, but it isn’t quite free in the metaphysical sense of actually commanding our individual destinies through the exercise of our own free will. At least some of the freedom of contemporary consumer society is an illusion, taken upon ourselves to make our lives feel bearable and to help us feel more in control—precisely because, to some extent, we are not very much in control at all.

Recommended, by your friend, namely me.

New issue of Econ Journal Watch

In this issue:

Are a Few Huge Outcomes Distorting Financial Misconduct Research? Emre Kuvvet confronts the extreme-values problem in firm penalties and other SEC enforcement outcomes against financial misconduct, and how outliers might affect research in finance, as well as policy judgment, focusing on an article in Journal of Accounting ResearchAndrew Call, Nathan Sharp, and Jaron Wilde respond.

Both terrorist and public mass shooter? In 2016 Adam Lankford published a news-busting article purporting to show that during a 47-year period the United States represented 31% of worldwide public mass shooters, and claiming that the outsized U.S. percentage is a result of gun prevalence. John Lott and Carlisle Moody criticize Lankford’s terminology and methods. Lankford replies to Lott and Moody. Once the terminological disputes are clarified, the issue that emerges is: Why does the United States have an outsized number of lone-wolf mass shooters? Lott and Moody offer explanations different than Lankford’s.

Another round on right-to-carry and violent crimeCarlisle Moody and Thomas Marvell have another go at John Donohue, treating the weighting of fixed effects by population and synthetic controls. Donohue, Abhay Aneja, and Kyle Weber respond.

Tennis and loss aversionMichał Krawczyk challenges a set of authors who read loss aversion in tennis data. Nejat Anbarci, Peren Arin, and Christina Zenker return serve.

Why Did Milton Friedman Win the Nobel Prize? James Forder and Hugo Monnery appreciate Friedman’s underappreciated early work on the complexity of stabilization policy.

Edmund Burke, liberal:

EJW Audio:

James Forder on Milton Friedman’s Early Work on Stabilization Policy

Leo Krasnozhon on Liberalism in Ukraine

John Cairns on the 1758 Pamphlet about Hair-Cutting in Edinburgh

Price Discrimination Versus Medical Tourism

In our principles textbook, Tyler and I open our chapter on price discrimination with the following:

After months of investigation, police from Interpol swooped down on an international drug syndicate operating out of Antwerp, Belgium.  The syndicate had been smuggling drugs from Kenya, Uganda and Tanzania into the port of Antwerp for distribution throughout Europe.  Smuggling had netted the syndicate millions of dollars in profit.  The drug being smuggled?  Heroin?  Cocaine?  No, something more valuable, Combivir.  Why was Combivir, an anti-AIDS drug, being illegally smuggled from Africa to Europe when Combivir was manufactured in Europe and could be bought there legally?

The answer is that Combivir was priced at $12.50 per pill in Europe and, much closer to cost, about 50 cents per pill in Africa.  Smugglers who bought Combivir in Africa and sold it in Europe could make approximately $12 per pill, and they were smuggling millions of pills.

Instead of smuggling the drugs to Europe, it’s also possible to send the European and American patients abroad. Gilead’s Solvadi, for example, is a very effective drug used to treat hepatitis C. In the United States a course of treatment costs about about $85,000 but due to an agreement between Gilead and generic manufactures in developing countries, in Egypt, India and much of the developed world it can be had for less than $1000. In an excellent piece, Four Reasons Drugs are Expensive, of Which Two are False, Jack Scannell illustrates the battle between arbitrageurs and pharmaceutical companies:

[The price difference] raises dreams of pharmaceutical tourism: “Enjoy a 12 week Grand Tour, where you can gaze at the awesome pyramids and the inscrutable Sphinx of Giza, explore the treasures of Tutankhamen, gasp at the wonders of Luxor, while basking in the sustained virologic response you can only dream of buying in the US.” Some may dream, but Gilead got there already and put its corporate towels on the sun loungers. Egyptians must prove residency to get Sovaldi. Tourists need not apply.

To prevent resale Gilead requires ID and it labels and tracks every bottle sold abroad:

[Patient IDs] will be used to put an identifying barcode on the bottles they receive with their name and other info. Not only can the code be used to guarantee only residents of the country get the drugs…the provisions require that patients then return a bottle to get a new bottle and allows them to get only one bottle of their prescription at a time, even though allowing them to get multiple bottles could “ease the burden on patients and health providers,” MSF says.

Médecins Sans Frontières are outraged by these restrictions but, as Tyler and I explain, the alternative is no sales in developing countries or one world-price and you can be sure that if there’s one world-price that price will be the US price and not the Egyptian price.

Some implications of monopsony models

More workers ought to be in larger firms, as those firms are afraid to hire more, knowing that bids up wages for everyone.  Therefore (ceteris paribus) the large firms in the economy ought to be larger.

Raising the legal minimum wage also reallocates workers into larger firms, and again makes them larger.

Tough stuff if you worry a lot about both monopoly and monopsony at the same time — choose your poison!

I have adapted those points from a recent paper by David Berger, Kyle Herkenhoff, and Simon Mongey, “Labor Market Power.”  On the empirics, they conclude: “Our theory implies that this declining labor market concentration increase labor’s share of income by 2.89 percentage points between 1976 and 2014, suggesting that labor market concentration is not the reason for a declining labor share.”  So the paper makes no one happy (good!): monopsony is significant, but has been declining in import.

The Destruction from an Asteroid Strike

The Day the Dinosaurs Died is an amazing tale of scientific discovery. You should read the whole thing. One sub-point, however, is a vivid description of the asteroid that wiped out the dinosaurs.

The asteroid was vaporized on impact. Its substance, mingling with vaporized Earth rock, formed a fiery plume, which reached halfway to the moon before collapsing in a pillar of incandescent dust. Computer models suggest that the atmosphere within fifteen hundred miles of ground zero became red hot from the debris storm, triggering gigantic forest fires. As the Earth rotated, the airborne material converged at the opposite side of the planet, where it fell and set fire to the entire Indian subcontinent. Measurements of the layer of ash and soot that eventually coated the Earth indicate that fires consumed about seventy per cent of the world’s forests. Meanwhile, giant tsunamis resulting from the impact churned across the Gulf of Mexico, tearing up coastlines, sometimes peeling up hundreds of feet of rock, pushing debris inland and then sucking it back out into deep water, leaving jumbled deposits that oilmen sometimes encounter in the course of deep-sea drilling.

…The dust and soot from the impact and the conflagrations prevented all sunlight from reaching the planet’s surface for months. Photosynthesis all but stopped, killing most of the plant life, extinguishing the phytoplankton in the oceans, and causing the amount of oxygen in the atmosphere to plummet. After the fires died down, Earth plunged into a period of cold, perhaps even a deep freeze. Earth’s two essential food chains, in the sea and on land, collapsed. About seventy-five per cent of all species went extinct. More than 99.9999 per cent of all living organisms on Earth died, and the carbon cycle came to a halt.

…One of the authors of the 1991 paper, David Kring, was so frightened by what he learned of the impact’s destructive nature that he became a leading voice in calling for a system to identify and neutralize threatening asteroids. “There’s no uncertainty to this statement: the Earth will be hit by a Chicxulub-size asteroid again, unless we deflect it,” he told me. “Even a three-hundred-metre rock would end world agriculture.”

When the asteroid hit it unleashed the energy of a billion Hiroshimas, that’s one reason I support foundations like the B612 Foundation who are working to map asteroids and develop systems to protect our world. As Tyler and I point out in textbook, protection from asteroids is a true public good which is one reason why we aren’t spending enough on this project.

Hat tip: Kevin Lewis.

Elizabeth Warren on food and agriculture

That is the topic of my latest Bloomberg column, here is on excerpt:

The most striking feature of her team’s plan, called “Leveling the Playing Field for America’s Family Farmers,” is what it doesn’t call for: namely, an abolition of farm subsidies, a reform favored by virtually all economists. Those payments often run more than $20 billion a year, and are typically considered an inefficient form of crony capitalism.

And:

Warren’s document asserts that “food prices aren’t going down.” That’s true but misleading. When the Federal Reserve is targeting near 2 percent inflation, most prices in the economy will rise steadily over time. The link behind that claim, to a U.S. Department of Agriculture report, offers some recent data, but it is hardly damning: In 2018, it notes, retail food prices rose 0.4 percent. “This was the first increase in 3 years, but the rate was still below the 20-year historical annual average of 2.0 percent.” Or how terrible are these numbers, from the same report: “In 2019, price growth may continue to remain low at the grocery store. Food-at-home prices are expected to rise between 0.5 and 1.5 percent, as potentially the fourth year in a row with deflating or lower-than-average inflating retail food prices.”

A look at the longer-term historical data also shows slow, steady inflation in the food and beverage sector, rather than a recent crisis of price spikes. Food price inflation does become higher after 1973, but that is probably due to higher energy prices and the more general productivity slowdown that has plagued the U.S. economy.

In this context, Warren’s lengthy complaints about monopoly and market power in the food sector just don’t seem that persuasive. Furthermore, America’s food sector has been remarkably innovative in terms of product choice and rising diversity of options.

Warren also calls for greater agricultural protectionism and the banning of foreign investment in American farmland.  And she is supposed to be the leading policy thinker in the race?  People, this is not good, and furthermore it is the same tiresome “tested by social media let’s bash the corporate villains” set of cliches.  My close:

If American voters want to be inspired, then opposing seed-company mergers won’t be nearly enough.

Demand curves slope downward incentives matter

The typical all-you-can-eat buffet customer serves herself more than 4 pounds of food—much of which winds up in the trash, he said. The by-the-pound guest, in contrast, serves herself 1-to-2 pounds and the more she takes, the better it is for the business.

Here is the longer story (WSJ), with additional points of interest, via the estimable Chug.

Paying People to Stay Out of Jail

Should we pay people not to commit crime? Could we? Murat Mungan from GMU Law shows that it could pay in principle:

This article considers the possibility of simultaneously reducing crime, prison sentences, and the tax burden of …financing the criminal justice system by introducing positive sanctions, which are benefits conferred to individuals who refrain from committing crime. Specifically, it proposes a procedure wherein a part of the imprisonment budget is re-directed towards financing positive sanctions. The feasibility of reducing crime, sentences, and taxes through such reallocations depends on how effectively the marginal imprisonment sentence reduces crime, the crime rate, the effectiveness of positive sanctions, and how accurately the government can direct positive sanctions towards individuals who are most responsive to such policies. The article then highlights an advantage of positive sanctions over imprisonment in deterring criminal behavior: positive sanctions operate by transferring or creating wealth, whereas imprisonment operates by destroying wealth. Thus, the conditions under which positive sanctions are optimal are broader than those under which they can be used to jointly reduce crime, sentences, and taxes. The analysis reveals that when the budget for the criminal justice system is exogenously given, it is optimal to use positive sanctions when the imprisonment elasticity of deterrence is small, which is a condition that is consistent with the empirical literature. When the budget for the criminal justice system is endogenously determined, it is optimal to use positive sanctions as long as the marginal cost of public funds is not high.

It’s harder to implement in practice, however. Increasing the minimum wage and the EITC might be easier or maybe not.

Hat tip: Kevin Lewis.

How NIMBY leads to urination in the streets

That is the topic of my latest Bloomberg column, here is one excerpt:

…step back and consider two 19th-century “classical economists” who focused on high rents: David Ricardo and Henry George. Both built models where land is so scarce that the cost of renting land absorbs most of the social surplus. We are not (yet?) at that point, but these models give insight into where today’s most expensive cities are headed.

Consider an increase in the quality of public services — say, garbage collection, or perhaps in San Francisco the elimination of public urination. You might think that would make life much better for everyone. But in a Ricardo-George model, that is not the case. Mainly what happens is that rents go up and landowners capture most of the newly created surplus.

How would this work? Take the example of San Francisco; with nicer streets, even more people might want to move there. That would push up rents by an amount roughly equal to the value created — putting the gains from the higher quality of life into the pockets of landowners. In a normal market economy, those higher rents would then induce more construction and, eventually, a corresponding decline in rents. But San Francisco is a “not in my backyard” locale where the amount of new construction just isn’t that high, for legal and regulatory reasons. Again, as both Ricardo and George realized, the incidence of the benefit falls upon the very scarce factor, namely land.

The political economy problem now should be obvious: Why exactly would non-landowners press for improvements in their cities? The value of those improvements will be captured mainly by other parties.

There is much more at the link.